MSCI to add overseas Chinese stocks this month

Index giant MSCI is planning to add some overseas-listed Chinese shares to its emerging markets indexes this month, which should lead to billions of dollars pouring into these stocks from mutual funds and other investment companies.

The key point here is that all the mutual funds, exchange-traded funds and institutional funds that track MSCI’s index, one of the most widely-followed emerging markets indexes, will need to buy the stocks that the index provider adds in order to make sure their funds closely track the index and provide a near identical return.

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So traders are trying to figure out which stocks will be included in the index, buy them now and then see the share prices get a big pop when the indexes find out what new stocks they now need to include.

This was one of the big causes of the Chinese stock market rout this summer. MSCI had said it was considering adding China’s domestically listed A-shares in some of its indexes. Many traders bought the A-shares in anticipation of the official June announcement. That was a major reason the Chinese market surged 60% through June.

The only problem was the index provider decided not to include the A-shares. Everyone who bought the mainland stocks in anticipation of a mutual-fund buying spree, realized they weren’t going to get the share-price pop, so they sold their shares. The sell-off was so severe, the Chinese authorities needed to institute a heavy-handed rescue operation that destroyed the market’s credibility. It caused many foreign investors to decide they didn’t want to get involved in a market with a government intervening so directly. The new additions will be the first gauge of how foreign investors feel about investing in Chinese stocks since then.

The new additions expected to be announced on November 12 will include overseas-listed China shares, known as American Depositary Receipts (ADR). The overseas-listed stocks are not influenced by the Chinese government’s influence over the mainland market.

“Not only do they offer a great way to get into China businesses that are geared towards the consumption story, (but also) being listed in the U.S. means they are prevented from the kind of manipulation we have seen in the China markets over the summer,” Marc Chandler, global head of FX strategy at Brown Brothers Harriman told Reuters.

Reuters said analysts estimate that the index rebalancing will see up to $70 billion flow into these stocks over the next six months and increase China’s weight in the MSCI Emerging Market index to more than 26% from just over 23%. Currently the index only includes Chinese stocks listed in Hong Kong.

U.S.-listed tech giants like Alibaba (BABA) and Baidu (BIDU) are expected to be included in the index.

“These are new-economy, creative companies, and investors will be excited about that, in stark contrast to many Chinese-listed shares that are more traditional state-owned-enterprise-type firms,” Arthur Kwong, head of Asia Pacific equities at fund manager BNP Paribas Investment Partners in Hong Kong, who manages $1.8 billion in assets told Reuters.

About a tenth of the potential $70 billion investment would flow in automatically via passive funds that track the indexes, but the rest depends on active fund managers, who are more circumspect after the events of the summer and wary of China’s slowing economy, said Reuters.